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Identity is the antidote for DEXs’ regulation problem

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Identity is the antidote for DEXs’ regulation problem

Regulators from Europe, the United States and elsewhere are busily hammering out details on how to designate decentralized exchanges (DEXs) as “brokers,” transaction agents or similar entities that affect a transfer and cooperate with each other. The U.S. called for multinational cooperation in its executive order on responsible digital asset development, as did the European Union with its recent Financial Stability and Integration Review. And that is just what’s publicly accessible. 

Behind the scenes, the whisper of regulation is getting louder. Did anyone notice that all the Know Your Customer (KYC) requirements have been laid on smaller centralized exchanges in exotic locations over the past two months? That was the canary in the coal mine. With the aforementioned designation and cooperation, DEXs will start to feel regulator heat soon.

Yes, regulations are coming, and the main reason why DEXs will hardly survive the coming storm is their proclaimed lack of ability to identify the users using and contributing to liquidity pools. In conventional financial circles, rendering services without proper KYC procedures is a big no-no. Not tracking identity allowed Russian oligarchs to use the Hawala payment service to anonymously move millions of dollars leading up to the war in Ukraine, so regulators are justifiably concerned about DEXs. For most DEX enthusiasts, KYC sounds like an insult, or at least, something that a DEX is fundamentally incapable of doing. Is that really the case, though?

Related: Crypto’s impact on sanctions: Are regulators’ concerns justified?

DEXs are actually pretty central

Let’s start with the anatomy of a DEX, and we’ll find that they aren’t even as decentralized as one may think. Yes, DEXs run on smart contracts, but the team or person that uploads the code on-chain usually gets special admin-level privileges and permissions. Additionally, a known, centralized team usually takes care of the front end. For example, Uniswap Labs recently added the ability to scrub known hacker wallets, removing tokens from their menu. While DEXs claim to be pure code, in reality, there is still a more-or-less centralized developer team behind this ethereal entity. This team also takes in any profits to be made.

Furthermore, an in-depth look at the way users communicate with permissionless chains reveals more centralized choke points. For example, last month, MetaMask was unavailable in a few regions. Why? Because Infura, a centralized service provider that the on-chain wallet relies on for an Ethereum API, decided so. With a DEX, things can always play out in a similar way.

Some people say that DEXs are more decentralized by virtue of being open source, meaning any community is free to fork the code and build their own DEX. Sure, you can have as many DEXs as you want, but the question is about which ones manage to bring more liquidity to the table, and where users actually go to trade their tokens. That is, after all, what exchanges are for in the first place.

Related: DEXs and KYC: A match made in hell or a real possibility?

From a regulatory standpoint, an entity facilitating such trades can be seen as a “broker” or a “transfer agent” regardless of whether it is open source or not. That is where most regulations are heading. Once identified as such, DEXs will take major fire unless they can comply with a wide array of requirements. These would include getting a license, verifying user identities and reporting transactions, including suspicious ones. In the U.S., they would also have to comply with the Bank Secrecy Act and freeze accounts upon request from the authorities. Without all of that, DEXs are likely to go under.

The identity-and-KYC issue

Since DEXs claim they are decentralized, they also claim that they are technologically incapable of implementing any identity verification or KYC controls. But in truth, KYC and pseudonymity are not mutually exclusive from a technological standpoint. Such an attitude reveals, at best, laziness or an unhinged push for lower costs, and at worst, a desire to profit from dirty money being moved around.

Arguments that a DEX is unable to do KYC without creating a honeypot of personal information lack technical merit and imagination. Multiple teams are already building identity solutions based on zero-knowledge proofs, a cryptographic method that allows one party to prove it has certain data without revealing that information. For example, proof of identity can include a green checkmark that the person has passed the KYC, but does not reveal personally identifiable information. Users can share this ID with a DEX for verification purposes without the need for a centralized repository of information.

Since their users don’t have to pass a KYC, DEXs become part of the puzzle when it comes to ransomware: Hackers use them as a major hub for moving bounty. Due to the lack of ID verification, DEX teams are unable to explain the “source of funds,” meaning they can’t prove the money doesn’t come from a sanctioned territory or from money laundering. Without this proof, banks will never issue a bank account for DEXs. Banks require information on the origins of funds so they don’t get fined or have their own license revoked. When DeFi can easily be used for criminal activity, it makes a bad name for crypto and pushes it further away from mainstream adaptation.

DEXs also have a unique and single-purpose suite of software, Automated Market Making or AMM, which allows liquidity providers to match with buyers and sellers, and pull in or determine a price for a given asset. This is not general-purpose software that can be leveraged for multiple use cases, as is the case with BitTorrent’s P2P protocol, which moves bits quickly and efficiently for Twitter, Facebook, Microsoft and video pirates. An AMM has a single purpose and produces a profit for teams.

Verifying user identities and checking that money and tokens are not illegal helps ensure some level of protection from cybercrime. It makes DeFi safer for users and more feasible for regulators and policymakers. To survive, DEXs will have to eventually admit this and adopt a level of identity verification and prevention of money laundering.

By implementing some of these solutions, DEXs can still deliver on the promise of DeFi. They can remain open for users to contribute liquidity, earn fees, and avoid relying on banks or other centralized entities while remaining pseudonymous.

Related: Want to weed out ransomware? Regulate crypto exchanges

If DEXs choose to ignore the regulatory pressure, it can end in one of two ways. Either more legitimate platforms can continue to adapt to growing government scrutiny and rising demand in crypto from more mainstream investors, who require usability and security, thereby leaving stubborn DEXs to die, or alternatively, unadaptable DEXs will move into the gray market of far-flung jurisdictions, tax havens and unregulated cash-like economies.

We have every reason to believe the former is a much likelier scenario. It’s time for DEXs to grow up with the rest of us or risk being regulated to death along with the shadier ghosts of crypto’s past.

This article does not contain investment advice or recommendations. Every investment and trading move involves risk, and readers should conduct their own research when making a decision.

The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.

Bob Reid is the current CEO and co-founder of Everest, a fintech company that leverages blockchain technologies for a more secure and inclusive multi-currency account, digital/biometric identity, payment platform and eMoney platform. As a licensed and registered financial institution, Everest supplies end-to-end financial solutions, facilitating eKYC/AML, digital identity and regulatory compliance associated with money movement. He was an advisor to Kai Labs, the general manager of licensing at BitTorrent, and vice president of strategy and business development at Neulion and DivX.

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Record Investment Outflows of $423 Million Led to Crypto Bloodbath

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Record Investment Outflows of $423 Million Led to Crypto Bloodbath

Last week saw record outflows of $423 million from crypto assets, according to CoinShares.

The report found that the outflows last weekend were likely responsible for bitcoin’s decline to $17,760. Analyst James Butterfill said: “The outflows were solely focussed on bitcoin, which saw net outflows for the week totaling US$453m.”

BTC outflows bring down institutional investments 

Therefore, if bitcoin is removed from the calculations, Ethereum contributed an inflow of around $11 million while other alts also added minor positive flows, aggregating inflows to the extent of $70 million. 

This was Ethereum’s first inflow after 11 consecutive negative sessions according to CoinShares.

In the past week, the BTC market has slid under the $20,000 level twice. Short-bitcoin saw inflows of $15 million due to the launch of the first U.S.-based short investment product in the week in question, the report noted.

[1/5] This week’s Digital Asset Fund Flows Report is now available! Written by @jbutterfill, the headline for this week is: Record US$423m outflows last week while Short-Bitcoin saw inflows of US$15m. Read on for the highlights -> pic.twitter.com/eIalnFhacv

— CoinShares 👩‍🚀 (@CoinSharesCo) June 27, 2022

Benefits of a crypto bear market

Similar wide margins were last seen in the previous negative peak, in terms of outflows, in Jan at $198 million.

However, in relative terms, Butterfill remarked that the week did not witness the largest negative flows against total assets under management (AuM). 

“This record occurred during the bear market in Feb 2018 where outflows representing 1.6% of AuM were witnessed, while the outflows last week were the third largest on record, representing 1.2% of AuM,” the report noted.

According to FTX CEO Sam Bankman-Fried, the Federal Reserve’s decision to aggressively increase interest rates was the main reason behind the market crash.

But despite the bearish sentiments, some crypto bosses are optimistic about the results of a market downturn. Charlie Silver, founder of Permission.io told Insider: ” There are hundreds of firms that are built on hype and not substance. It will be good for the industry to have them go away.”

“Bear markets are healthy because it resets valuations to reality and flushes out the bad actors. There are many cryptos that are true Ponzi schemes, that pay investors only with new investor money. When the new money dries up the project falls apart,” Silver added.

Disclaimer

All the information contained on our website is published in good faith and for general information purposes only. Any action the reader takes upon the information found on our website is strictly at their own risk.

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Uzbekistan warms up to Bitcoin mining, but there’s a catch

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Uzbekistan warms up to Bitcoin mining, but there’s a catch

The executive order spares all the mined assets from taxation and bans mining anonymous currencies.

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Uzbekistan warms up to Bitcoin mining, but there’s a catch

The National Agency of Prospective Projects (NAPP) in Uzbekistan announced its demands toward crypto mining operators. It would only allow the companies that use solar energy to mine Bitcoin (BTC) or other cryptocurrencies. 

The normative act on the government page, dated June 24, describes the confirmation of “Guidelines on the registration of the crypto assets mining,” and sets the finalization date on July 9. The second article of the document offers an uncompromising wording:

“Mining is being carried out only by the legal entity with the use of electric energy, provided by a solar photovoltaic power plant.”

As a further complication, the miners should own the solar photovoltaic power plant that they will use for energy.

The executive order also obliges any mining operator to obtain a certificate and register in the national registry of crypto mining companies. This procedure demands a brief list of documents, and should take no more than 20 days from submitting to the final decision to the licensing body. The certificates would be valid for one year after the registration.

Related: Go green or die? Bitcoin miners aim for carbon neutrality by mining near data centers

All the currency generated from mining activities would be spared taxation, though the mining farms would face the special tariffs on the consumed energy set by the Uzbekistan government. But, the trade operations with mined assets would have to be conducted only on the exchange platforms that are registered in Uzbekistan. The mining of anonymous cryptocurrencies would be prohibited.

In April 2022, the freshly-restructured NAPP became Uzbekistan’s exclusive crypto regulator with the mission to adopt a special crypto regulation regime in the country. This move came in a row of initiatives launched by the Uzbekistan President Shavkat Mirziyoyev to provide the regulatory framework for crypto. In September 2018, Mirziyoyev signed a law prohibiting local firms from launching their crypto exchanges in Uzbekistan. The law only offered legal status to crypto exchanges established by foreign legal entities.

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Celsius denies allegations on Alex Mashinsky trying to flee US

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Celsius denies allegations on Alex Mashinsky trying to flee US

Celsius CEO Alex Mashinsky wasn’t trying to leave the U.S. last week but has continued to work on recovering liquidity and operations, the company has claimed.

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Celsius denies allegations on Alex Mashinsky trying to flee US

Troubled crypto lending firm Celsius is putting their best foot forward to recover operations alongside CEO Alex Mashinsky, who currently stays in the United States, the company has claimed.

A spokesperson for Celsius has denied rumors that the company’s CEO tried to flee the U.S. last week amid the ongoing liquidity crisis of the Celsius Network.

The representative told Cointelegraph on Monday that the firm continues working on restoring liquidity, stating:

“All Celsius employees — including our CEO — are focused and hard at work in an effort to stabilize liquidity and operations. To that end, any reports that the Celsius CEO has attempted to leave the U.S. are false.”

Celsius’ statement came shortly after Mike Alfred, co-founder of the crypto analytics firm Digital Assets Data, took to Twitter on Sunday to claim that Mashinsky attempted to leave the country last week via Morristown Airport in New Jersey.

Citing an anonymous source, Alfred alleged that Celsius’s CEO was trying to go to Israel. “Unclear at this moment whether he was arrested or simply barred from leaving,” he added.

Alfred’s claims followed a massive GameStop-like “short squeeze” of Celsius, with Celsius’ native token Celsius (CEL) jumping 300% in one week by June 21. CEL price also abruptly rallied more than 600% on June 14, with analysts attributing the event to an exchange glitch or liquidation of short traders.

At the time of writing, CEL is trading at $0.741, down around 5% over the past 24 hours, according to CoinGecko. Celsius’ native token is still up more than 160% over the past 14 days.

Celsius Network token (CEL) 30-day price chart. Source: CoinGecko

Some industry observers in the crypto community have expressed skepticism about Alfred’s tweets about Mashinsky, with many considering his allegations as FUD.

If @Mashinsky attempted to leave the country this week, why are you reporting it now exactly when the CEL price is going down? Seems very coincidental Mike Alfud. And why no mainstream media or crypto media is reporting this? #CelShortSqueeze https://t.co/ynJbzWib9o

— Otis — #CelShortSqueeze ©️ ⚡️ (@otisa502) June 27, 2022

As previously reported by Cointelegraph, Celsius officially announced that it would be “pausing all withdrawals, swaps and transfers between accounts” on June 13. United States regulators subsequently started an investigation into Celsius as multiple accounts on the network were frozen.

Related: South Korean prosecutors ban Terraform Labs employees from exiting the country: Report

According to some analysts, Celsius’ liquidity issues should be attributed to shortcomings of the existing crypto lending model in general, as other lenders in the market have faced similar problems recently.

Celsius has been working hard to fix the consequences of the platform’s liquidity crisis, reportedly onboarding advisers and restructuring consultants to help the platform handle potential filing for bankruptcy. On June 18, Celsius’ lead investor BnkToTheFuture and its co-founder Simon Dixon offered to assist the network by deploying a recovery plan.

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